Small Employers Consider A Defined Benefit Plan

You may be familiar with the dire state of many pension funds in the recent past and currently. In fact, an Examiner review of federal actuarial reports shows almost half of the nation’s 20 largest unions have pension funds that federal law classifies as “endangered” or in “critical” condition due to being underfunded. Nevertheless, if you are a small business owner, there are good reasons to consider a pension plan as a component of your overall plan for retirement. Consider the following…

What Is A Defined Benefit Plan?

Unlike Defined Contribution (DC) Plans (IRAs, 401Ks, etc.), in which the amount of the contributions is predetermined annually, but the final benefit amount is unknown; Defined Benefit (DB) plans define the monthly benefit to be received by the plan participant while the amount necessary to be contributed by the company to meet the set goal of the plan would have to be redetermined each year.

The benefit is determined according to a formula based on the recipient’s salary and years of service. For instance, a plan formula that provides a monthly pension at age 65 equal to 1.5 percent for each year of service multiplied by the monthly average of a participant’s highest three years of compensation would provide a participant with 10 years of service, a monthly pension equal to 15 percent of the monthly average of the participant’s highest three years of compensation.

Benefits to Employee

Benefits may not be reduced as a result of investment performance.

Older employees may not be discriminated against but may receive favored treatment. Their accrued benefit must be equal to or greater than that of any other similarly situated employee.

Benefits are usually higher than those from a defined contribution plan.

Contributions are made by employer.

Advantages and Disadvantages to Employer

A substantially greater deduction to taxable income is possible since contributions up to $195,000 per employee may be made, whereas DC plan limits are $49,000 or 100 percent of income.

Unlike DC plans forfeited benefits are not distributed among the plan participants but may be used to reduce future contributions by the employer.

DB plans are more complicated to administer than DC plans, requiring an actuary and advisor.

Benefits of DB plans are guaranteed (to a limit) by the government through the Pension Benefit Guaranty Corporation (PBGC).

Although more complex, due to their efficiency, they actually provide “the same retirement income at nearly half the cost”, according to the National Institute for Retirement Security.

Types Of Pension Plans (DB Plans)

Two basic types of defined benefit plans are the Traditional Pension Plan and the Cash Balance Pension Plan. Traditional Pension Plans define the employee’s promised benefit in terms of an amount to be paid monthly from retirement through the life of the employee. Cash Balance Pension Plans however, present the benefits as a stated account balance similar to that of a 401(k).

Who Should Have A DB Plan?

Defined Benefit Plans are especially appealing to self-employed or small business owners, age 45 or older, whose companies are well established, with consistently high taxable income, and few employees who are significantly younger or lower paid.

Considerations

As many have learned during this recession, no retirement plan is completely “fullproof”. There is always risk involved, whether it is risk of loss from the market, or from the failure of commercial or government institutions. No one can completely guarantee, that a particular bank, or insurance company, or even that federal government safeguards such as Social Security, will be able to provide the funds sufficient to care for you comfortably in retirement.

This does not mean however, that you should abandon all hope of saving for retirement. Those who do prepare and save for retirement are far more likely to be better off than if they had not saved. Instead minimize your risk and consider the suggestions below when putting together a retirement plan.

Spread your risk over different investments.

If possible, make use of both a defined contribution and defined benefit plan guaranteed by different institutions.

Examine your tax obligation and consider the benefits of triple-compounding through qualified plans.